UK economic growth may lag expectations in 2025

Goldman Sachs Research expects continued growth from the UK economy in 2025, although its expansion may be slower than some economists anticipate.

Our economists forecast the UK's GDP to increase 1.2% in 2025, which is slower than the Bank of England's projection of 1.5% and just below the consensus estimate of economists surveyed by Bloomberg of 1.3%. The team forecasts 0.4% growth in the first three months of 2025 relative to the last three months of 2024, slowing to around 0.25-0.30% quarter on quarter in the rest of next year.

The British economy will be impacted by several key factors including uncertainty around trading arrangements with the US, a less expansionary budget, and proposed changes to the planning system for housing and development.

Our economists expect inflationary pressures to ease through 2025, introducing the potential for deeper interest rate cuts than the market has priced in. Market prices suggest the BoE will stop reducing interest rates at 4%, but our economists believe the central bank will continue cutting as far as 3.25%.

"We continue to think that the BoE will likely cut further than the market currently expects as measures of underlying domestic inflation fall back and demand comes in somewhat weaker than the Monetary Policy Committee's latest forecast," Goldman Sachs Research's Chief European Economist Sven Jari Stehn writes in the team's report, which is titled "UK Outlook 2025: A Gradual Pace, but More Cuts Than Priced."

How will US tariffs impact the UK economy?

The UK's trading arrangements will be a major focus next year. Uncertainty surrounding potential tariffs from the administration of US President-elect Donald Trump will likely weigh on confidence and is expected to notably reduce euro area growth. These tensions could also spill over into the UK, though probably to a lesser degree.

Given the openness of the British economy, a global shift towards increased tariffs could hurt the country's growth prospects. On the other hand, recent reports have indicated that the US may consider offering the UK a free-trade agreement in return for potential changes to food standards and greater market access for US healthcare companies.

The UK could also pursue closer ties with the EU: The government plans to strike a veterinary agreement, and Chancellor Rachel Reeves has hinted at regulatory harmonization in the chemicals sector. But the growth boost from these developments wouldn't be enough to meaningfully reduce the costs of Brexit, and it could run counter to closer trading relations with the US.

The outlook for the UK budget

The UK's autumn budget was more expansionary than expected, raising the prospect of stronger demand in the near-term. Even so, the updated plans still indicate consolidation in 2025, and growth is expected to cool in the second half of the year. The Office for Budget Responsibility will deliver a forecast update in the spring, which will be closely watched by markets.

"The government has left limited headroom against its new fiscal targets, and relatively small changes in the OBR's macroeconomic forecasts could eliminate this headroom entirely," Stehn writes.

Our economists think economic growth may prove lower than the OBR's projections, increasing the chances that the OBR will revise its debt-to-GDP forecast upwards.

Planning reform could gradually boost UK GDP growth

The government also intends to reform the planning system for housing and development. Although it's difficult to quantify the effect of the reforms without further policy details, our economists broadly expect the changes to result in a boost to residential investment over the next five years.

But the impact of any planning reforms on GDP growth over the medium term will depend on whether they increase labour productivity. A range of studies show that wages and productivity are higher in large cities, so relaxing planning restrictions could boost aggregate productivity by allowing urban areas to expand.

"Some studies have indicated that this effect could be sizeable in the very long run," Stehn writes. "But we would expect any boost to productivity to occur gradually over an extended period of time."

Inflation is forecast to ease in 2025

Inflation is expected to be firmer in the near term, easing throughout 2025. Public sector pay deals and government consumption following the autumn budget will support strong demand, while increases in vehicle excise duty and the introduction of VAT on private school fees could drive up prices in the services sector.

Nonetheless, Goldman Sachs Research sees domestic inflationary pressures falling back next year. Data from surveys conducted by the BoE suggest that tightness in the labor market is also likely to ease.

"This continued easing in labour market tightness - together with reduced catch-up effects now that inflation has returned close to target - are likely to result in a notable slowing in pay growth next year," Stehn writes.

Reduced pay pressures are likely to result in services inflation declining gradually. This could lead to headline inflation undershooting the BoE's latest projections: Our economists' analysis puts headline inflation at around 2.3% in the final quarter of 2025, four-tenths below the BoE's November forecast. They expect core inflation to fall to 2.5% by the end of next year.

The outlook for BoE rate cuts

Goldman Sachs Research expects the BoE to cut interest rates further and over a longer period than the market anticipates during this cutting cycle.

Our economists anticipate that the BoE will hold rates steady at 4.75% in December, given that inflation and growth are likely to remain firm in the near term. But with slowing inflation now likely in 2025, Goldman Sachs Research predicts quarterly cuts to interest rates throughout next year and into 2026, until the Bank Rate hits 3.25% in the second quarter of 2026.

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